Market uncertainty, persistent arbitrage-free violation, and price discovery in RMB market*

This paper applies a fractionally cointegrated vector autoregressive model to examine time-varying price discovery between Chinese renminbi onshore and offshore exchange rates. We study the impact of the equity market and economic policy uncertainty level on price discovery and the arbitrage opportunities between the onshore and offshore markets. The results show that the less regulated offshore rates dominate in price discovery, and a higher market uncertainty level strengthens the leading role of offshore rates in price discovery. However, a higher market uncertainty would increase the bid-ask spread and investors' risk aversion degree and then impede the whole price discovery. Finally, higher uncertainty would induce persistent arbitrage opportunities in renminbi onshore and offshore markets.